A Definitive Guide to Asset-Based Finance
- Asset-based finance or asset-based lending requires borrowers to put up collateral to qualify.
- Some of the most common collaterals you can use are real estate, accounts receivables, heavy equipment, and inventory.
- Note that lenders won’t offer a fixed interest rate for asset-based loans. Your rate will depend on a number of factors, such as the quality of your customers and your payment history with suppliers.
Businesses need working capital to ensure continuous growth. However, it requires a considerable amount of time and effort to get enough funds to support your goals-may it be to relocate to a new city, hire more people, or purchase new equipment. Not to mention, most small business loans require a certain criteria before lending you a huge amount of money, such as length in business and a high enough credit score.If you need the funds now for huge investments, one of the best ways to get more capital is through asset-based finance. This article will delve more into asset-based financing as a viable solution to accelerate your growth at a time when it seems almost impossible to get one.
What is Asset-Based Finance?
Asset-based finance (also known as asset-based lending) is a form of small business lending that uses inventory, equipment, real estate, or accounts receivables as collateral. It is often used to pay for expenses when there are temporary gaps in a company’s cash flow, such as refinancing existing loans or replacing worn-out machinery with heavy-duty ones.
Asset-based lending is different from cash flow-based loans, as the latter relies on your company’s future outputs and cash streams for repayment. Asset-based finance depends on the assets you hold in your business.
Most borrowers of asset-based finance are small to medium-sized businesses since they often need sufficient funds for expansion and they have valuable tangible assets.
On the lender’s perspective, most would prefer collaterals that are liquid in nature or those that can easily be turned into cash, supposing that the borrower fails to repay their loan. That said, note that even though you have properties, inventory, or machineries to put up as collateral, you might want to show a well-balanced account to increase your chances of getting approved.
What Collaterals Can You Use to Apply for Asset-Based Financing?
- Accounts Receivable
- Machines and Equipment
- Real Estate
A collateral is the asset you put up as leverage for the lender in case you default your loan. It is reported in your balance sheet, which is bought or created to increase your company’s value. Collaterals are often required by lenders to reduce their risk of loaning you money, especially when your credit score is low or you haven’t been in business for years.
Assets can take the form of tools, equipment, real estate, stocks, bonds, invoices, and even intellectual property rights such as patents. Collaterals often dictate how much loan you can ask from a financial institution.
A general rule of thumb when selecting assets for collateral is that they must be liquidatable. Lenders prefer this because they can easily convert them to cash to cover any unpaid debts and avoid financial losses on their end.
The following are the most recommended assets that can be used as collateral:
- Accounts Receivables. These are payments your company expects to receive within 90 days. Considering several factors such as collection periods and your business account’s diversification, your lender can offer 70% to 90% of its value as asset-based finance.
- Inventory. Your inventory may also be offered as collateral if you are in the business of manufacturing, retailing, or wholesaling. Lending firms will usually value your inventory depending on the item’s nature (e.g., non-perishable, expiring, etc.), their marketability, and ability to gain profit in a short amount of time.
- Machines and heavy equipment. The heavy machineries and equipment you have in your company may also be used as collateral. However, their loan equivalent may vary depending on the equipment’s current market value. Take note that machines depreciate in value over its usable lifespan, so you might not be able to get the loan amounting to the price you bought it for.
- Real Estate. As one of the most common assets used as collateral, real estate properties are almost guaranteed to secure a loan. A third-party land appraiser will determine the value of your real estate to know its current market value and future appreciation values.
Depending on your assets’ liquidability, lenders would usually grant you 50% to 90% of its value as the loan amount you can apply for. For example, if you declared your business’ accounts receivables valued at $250,000 as collateral, your lender could offer you 80% of its current market value for the loan, amounting to $200,000.
On the other hand, if you would be using a heavy machine such as a crane currently valued at $10,000 as collateral, you may be able to only get 50% of its value at most ($5,000), since it is an asset that depreciates over time and is very hard to liquidate.
Advantages of Asset Based Financing
There are many reasons why you should opt for asset-based finance when money gets tight:
- Accessibility. Generally, asset-based loans can be more accessible than their cash flow-based counterparts. One reason is that many are willing to lend money to borrowers who are willing to risk their assets. This gives lenders the assurance that they will be paid off no matter what happens.
- Considered as cash advances. Putting up your assets as collateral can work wonders for your business. Even though you’ve risked your asset being taken away from you, you know for sure that you’ll pay back the loan in time. Asset-based finances are basically an easy cash advance if you can capitalize on your asset’s value.
- No credit requirement. Unlike traditional forms of small business loans, asset-based finances won’t require you to show good credit standing in order to qualify. You only need to put up an asset that’s of value to your lenders.
Disadvantages of Asset-Based Financing
Just like any type of loan, asset-based financing comes with disadvantages too. Check out the list below:
- Limited asset options. Not all assets you own can be used as collateral. Most of the time, lenders would prefer assets that can be easily liquidated and have low depreciation rates so they can get back the cash owed in case you default on the loan.
- Long processing time. Since you are potentially exchanging your assets with the loan you applied for, lenders would need to audit and appraise them, which will take time. Getting an asset-based loan would not be ideal if you need the funds as soon as possible.
- Your assets are at risk. This is the main drawback of asset-based loans — you can lose your company assets when you cannot repay the amount. It would be a critical blow to your business if lenders seized your assets.
Asset-based finance rates
The interest rates will vary depending on a number of factors. Just to give you an idea, interest may go anywhere between 5.25% to 15% and can be structured as an asset-backed line of credit or term loan.Below is a list of everything you need to consider:
- Size and quality of your clients, including length of business relationship
- Previous payment history with clients
- Proof of business profitability
- Age and quality of machinery or equipment
- Length of payment terms with client (30 up to 90 days)
- Business credit score
- Vendor payment history
- Property value based on recent appraisal
- Frequency at which your inventory churns
- Length of business operations
Asset-based finance general requirements
If you think that asset-based loans are best for you, here are the documents you need to prepare beforehand.
- Property value according to the appraiser
- Updated balance sheet
- Accounts receivable and accounts payable aging report
- Business tax returns
- Debt schedule
- Inventory report
Asset-based loans are one way to buff up your capital to give your business financial flexibility or push for your company’s growth. But just like when you’re applying for any type of loan, you need to coordinate with your lenders to know the best options for you.